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The stock of Supervalu (NYSE:SVU) has just been crushed over the last several weeks, at one time declining by over 50% during a two-day period. While many other writers have opined on the investment merits of Supervalu stock, the focus here will be on whether Supervalu's debt, specifically its notes and debentures, may be worthwhile investments. During this discussion, I will consider SVU's debt on a standalone basis, and also in comparison with other grocers, such as Safeway (SWY), Kroger (NYSE:KR), and Delhaize Group (NYSE:DEG). Other grocers beyond those listed exist of course, but because of differences in either their debt load, or size, I will exclude them from this comparison.

Standalone Investment Merits

Firstly, Supervalu has notes under three different names, because Supervalu acquired other, smaller grocers prior to becoming the company it is today. SVU's debt also bears the Albertson's and American Stores names. Here is a table listing Supervalu's debt. The left column indicates its book value, or original issuance value (source: SVU 10-Q), and the right column indicates the debt's value at current market prices. Since these values change daily (though not by a large amount), these numbers are to a certain extent approximations.

Description

Face

Discount

Market

8% notes due 2016

1000

87%

870

7.45% debs. due 2029

650

59%

384

7.5% notes due 2014

490

94%

461

6.3%-7.15% notes, various

440

75%

330

8% debs. due 2031

400

60%

240

7.5% notes due 2012

-

-

-

8% debs. due 2026

272

82%

223

8.7% debs. due 2030

225

60%

135

7.75% debs due 2026

200

70%

140

7.25% notes due 2013

140

100%

140

A/R Facility

130

100%

130

7.9% debs due 2017

96

92%

88

Other

51

100%

51

Capital leases, revolver, other

2450

100%

2450

Total

6544

5641

* 6.3%-7.15%, various: 75% is approximation

The market value of all the notes and debentures is about $3.3 billion. SVU projected free cash flow of about $500 million going forward. Assuming that free cash flow does not decline over the relevant time period, it will be able to completely repay all of its notes and debentures in about six years.

As a result of the recent decline in the shares and corresponding notes, some of the notes sell at large discounts to face value. For example, the 8.7% notes due 2030 sell at about 60 cents on the dollar, giving them an approximately 15% current yield, a boon to income investors in this era of ultra-low rates.

Competitors Comparison

SVU has gotten quite a bit of flak from the investment community for both its lackluster operational performance and also for its financial management, including over-indebtedness. It seems that, no matter what strategy the company tries, it gets panned, including its recent low-price strategy. Finally, skeptics point to declining operating metrics like sales, margins, etc. However, the supermarkets below also have some or all of these warning signs, although to date they have been largely ignored by investors.

Competitors' Balance Sheet and Operating Metrics

Metric

SWY

KR

DEG

SVU

Debt to Assets

44%

35%

24%

63%

EBIT margin

3%

4%

5%

NMF

% Sales change, YOY

6%

10%

-2%

-4%

* D/A includes revolvers but not accounts payable

Of course, SVU's debt figures in the chart above are using face values, not market values, which are about $1 billion lower. My conclusion from the above chart is that SVU is not drastically different (different rather by a matter of degree) from the other grocers. Of course, SVU's high leverage is a concern. However, although SVU is more levered, Safeway's management, for example, is increasing debt at a mildly alarming rate as well. All of the supermarkets in the above chart are low-growth, low margin, but stable businesses. Although SVU's sales have declined, so have Delhaize Group's. In any case, an investor in SVU's bonds is protected from further deterioration in operating metrics by at least two factors: (1) his seniority relative to the stock (this would come into play in the event of bankruptcy); (2) his right to receive interest payments, which cannot be cancelled unlike the stock dividend was recently, except in the event of default.

Finally, although criticisms of SVU's business model may be credible (its recently panned low-price strategy, etc.) SVU is really a portfolio of rather diverse businesses, although they all come under the food retailing umbrella. Recently SVU began breaking out results by segment, and it appears that Sav-A-Lot, at the least, is a diamond in the rough, growing sales about 10% last year, while the "Independent Business" or distribution business is much lower margin and may be in more of a struggle.

Therefore, the combination of seniority in capital structure, inherent stability of the supermarket or food distribution business, and interesting portfolio companies make this a potentially worthwhile investment, especially at current, already low, - or future, possibly even lower, prices.

Disclosure: I may initiate a position, depending on market prices, though I have no position at this time.

Source: The Bull Case For Supervalu Bonds